How Risky Is Bitcoin?

Bitcoin continues to be a hot topic. Prices for the digital currency rose by more than 1,000% in 2017, but are down more than 49% so far in 2018. In December 2017, Bitcoin futures started trading on two major U.S. exchanges.

This has left some investors wondering: What’s the big deal with Bitcoin? How risky is it, and is it something I should consider for my own portfolio? Here are some facts:

What is Bitcoin?

Bitcoin is a digital currency—or “cryptocurrency”—that allows online payments to be made directly from one party to another through a worldwide digital payment network, without the need for a central third-party intermediary such as a bank. Records are held on a distributed public ledger called the blockchain that is stored and duplicated on thousands of computers throughout the world. While there are more than 1,500 different types of cryptocurrencies, several examples other than Bitcoin include Litecoin, Ethereum, Ripple, and Zcash, to name a few.

The global supply of Bitcoins is increasing through computer “mining”—a record-keeping service that involves repeatedly verifying and collecting new coins into a group of transactions called a block. The total supply is fixed at a maximum of 21 million coins. To date, about 16.9 million Bitcoins have been created—although Chainalysis, a digital forensics company, has estimated that somewhere between three and four million already may have been lost (for example, through irrecoverable passwords or people who accidentally threw away Bitcoin collections back when they weren’t worth very much).

Like physical gold, which is likewise not backed by any central bank or government, Bitcoin’s value stems primarily from its scarcity and public faith in Bitcoin as a store of value, means of payment or hedge against inflation.

Why is Bitcoin’s price so volatile?

As of April 11, 2018, the price of a single Bitcoin was about $6,900 and people around the world held approximately $117 billion in Bitcoins.¹ At this price level that exceeds the market capitalization of such bellwether companies as Nike, American Express and Caterpillar. It is relatively small, however, compared with the $6 trillion value of all outstanding gold bullion, and the market capitalization of $23 trillion for the stocks in the S&P 500® index.

“Because Bitcoin is limited to 21 million coins, and an estimated four million have already been lost, there is a large demand and a relatively small supply. Typically, that is a recipe for high volatility,” says Randy Frederick, Vice President of Trading and Derivatives at Schwab.

“Since two major futures exchanges began listing contracts on Bitcoin in December 2017, price declines may be partially attributed to greater price discovery, due to the ability to sell short in the futures markets,” Randy says. “Plenty of speculators, however, continue to buy Bitcoin due to the fear of missing out on something that has provided large profits—but also high risk—to many buyers.”

How do you buy Bitcoin?

Bitcoin can be obtained through various methods, including paying cash for them through an exchange like Coinbase, providing goods or services in exchange for Bitcoin, buying from a Bitcoin ATM, or by mining Bitcoins with a computer.

Currently, it is not possible to buy Bitcoins on any exchange regulated by the Securities and Exchange Commission (SEC), nor through an SEC-approved mutual fund or exchange-traded fund. Proposals submitted to the SEC for such products have been rejected, largely due to the current lack of Bitcoin market regulation and fragmented markets, Randy says.

However, Cboe Global Markets Inc. and the CME Group Inc. both launched Bitcoin futures trading in December 2017.

Can I trade Bitcoin at Schwab?

Beginning April 6, 2018, clients with a Charles Schwab Futures account can trade Cboe Bitcoin Futures (XBT) on the StreetSmart Central or StreetSmart Mobile trading platforms. Schwab does not currently offer trading in the CME Bitcoin futures product (BTC), but may choose to offer it at a future date.

What’s the price of Bitcoin right now?

Charles Schwab does not track the individual prices of cryptocurrencies. For clients interested in the Cboe or CME futures prices, real-time quotes can be monitored on StreetSmart trading platforms. For clients interested in tracking the price of the underlying cryptocurrencies, there are many different exchanges that offer quotes, such as Coinbase or Gemini. An easy way to track the price of Bitcoin on Schwab platforms is to watch symbol $GXBT, which is the Gemini Bitcoin Trade Price Index.

Know the risks

“Bitcoin’s dramatic rise and fall has been driven primarily by supply and demand, not valuations,” Randy says. “Bitcoin doesn’t have earnings or revenues. It doesn’t have a price-to-earnings ratio, price-to-sales ratio or book value. Traditional value metrics simply don’t apply, so there are no current methods for assessing its value.”

With a price gain of more than 4,000% in a little more than two years, Bitcoin was definitely in a bubble by most definitions, Randy says. And while the price has fallen more than 63% since the highs reached in mid-December, it is still up more than 80% over the past 12 months, so it’s important for investors to understand that investing in Bitcoin is extremely risky, he says.

Risks include:

  • Financial loss: Bitcoin prices historically have been highly volatile, and fluctuations could result in significant losses for investors.

  • Fraud and cybercrime: These already have occurred. For example, in 2011, Japan-based Mt. Gox, then the largest Bitcoin exchange, experienced a security breach in which 850,000 Bitcoins worth approximately $450 million were stolen. In November 2017, a cryptocurrency called Tether reported a $31 million theft.

  • Theft or loss: A login ID and password is usually needed to access the exchange, so if that is forgotten, lost or stolen by a hacker or phishing scam, access could be denied or lost. Online purchases still require a link to a bank account and/or a credit card. While Bitcoins can be stored in physical wallets so they can be spent without a computer, this creates the same risks as with all cash currencies: They could be lost, stolen or destroyed by accident.

  • Computer outage or cyberattack: Bitcoin exchanges have been subject to computer outages caused by excessive demand or other problems. Also, because ledgers and most holdings are held on the internet, a large-scale cyberattack could limit access during times of national emergency, something that would not happen with physical cash or gold.

  • Lack of regulation: Trading in Bitcoin and other cryptocurrencies is largely unregulated. Washington has been devoting more resources to monitoring digital currencies, but regulators have not reached a consistent or universal stance.

“Bitcoin doesn’t fit within accepted asset allocation models, as it is neither a commodity nor currency in the traditional sense,” Randy says. “Virtual currencies are highly volatile and still lack many of the regulations and consumer protections that legal-tender currencies have. Due to the high level of risk, investors should view Bitcoin as a purely speculative instrument that should only be traded with money that they can afford to lose.”

¹ Source: Coinmarketcap.com

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